A China WFOE Shutdown, Baltimore Colts Style

A while back (I am being intentionally vague here to avoid identifying anyone) a U.S. client company contacted me about shutting down its China WFOE and/or terminating all of its roughly 20 China employees in one fell swoop. The U.S. company had discovered rampant corruption among its employees and its CEO wanted all of this to be done “by tomorrow.” I am not kidding!

My response (modified to hide any identifiers and ` into one email) was as follows, with the client identified below as “Company A.”

I spoke with Grace Yang (our lead China employment lawyer) and with Steve Dickinson (our lead China corporate lawyer) and both agree that there is no way we can provide you with anything even approaching sound advice by tomorrow.

You essentially have two choices. One, you slink away in the middle of the night and neither Company A nor anyone who China might ever identify as having been associated with Company A ever goes to China again and Company A never conducts any business with China again. If (as I pretty much know will be the case) this does not appeal to you, then you must provide prior notice to the government because what you are proposing to do almost certainly constitutes what China calls a “mass layoff.” We will need to confirm with the authorities that such notice will be required because the definition of mass layoff varies depending on the local labor bureau. But we are virtually certain it will be.

Once we know exactly the layoff situation with which we are dealing, we can work with you to figure out the best, the fastest, and the cheapest way to accomplish it. If you have any employees who are pregnant or any employees for whom this will present a significant financial hardship, this will get even more complicated.

In addition to the employee issues, you also will need to work with the government in shutting down the WFOE itself and that can be an even longer and more drawn out process than dealing with the employment issues. We typically bring in accountants to assist with WFOE closures because taxes are so central to this. We have worked with a couple of very good accounting firms in ___________[Chinese city] and we would want to bring one of them in for this closure. This is going to take a substantial amount of legal work on our part, gathering up the facts, researching the law, and meeting with government officials.

What I can tell you at this point is that how we handle this will very much depend on the facts. It will depend on the size of the WFOE (my client contact did not even know how many employees the company had in its China WFOE]. The reason for the layoff. The types of employees you have: some may need to be differently than others. The location. The economy in your location. The labor bureau office. Your company’s history. Your company’s plans for the future, including not just China but other countries. I could go on and on and I’m sure Grace and Steve can and would add many more things to this list once we get going on this. We have seen these sorts of terminations/shutdowns done right and we have seen these terminations/shutdowns done wrong and usually when they are done wrong really bad things happen, like people being held hostage in China or seized by the government when they go over there a few years later. When they are done right, they take a lot of thought and a lot of varied expertise and, most importantly, a lot of time.

If what you are proposing is a mass layoff — and we are virtually certain it is — there are certain procedures that must be followed, and those procedures vary by district, by city and by province. If it is a mass layoff, almost everything will likely need to be made public and the language used in the public notice thus becomes absolutely critical. The last thing you want is for your terminations to become this week’s big issue for labor activists. We will need to meet with the employee/union representatives or all of the employees to discuss severance. What can go wrong there? Well, one of the last times I was in Beijing, the talk of the town was an investment banker who went to meet with employees in a situation not all dissimilar to this, but without a plan. He was literally beaten to death. That’s obviously a rarity, but it does show the need to have a well thought out plan in place before doing anything.

The labor authorities will get involved and they have tremendous power to correct anything they think wrong with the WFOE’s mass layoff proposal. And the last thing you want to do is start out too harsh and thus anger them from the get-go. On the flip side, if we can win over the local labor authorities with a good plan, we can likely get them to assist in the whole process.

The above is mostly just the labor issues. Closing down the WFOE will have its own issues, mostly relating to first clearing up the labor issues, and any debt and tax issues. The tax issues tend to be worst of all because once a company starts closing, taxes start coming out of the woodwork. That is why we also will almost certainly want to bring in a high level yet local tax accountant. Oh and employees almost always file a claim against the WFOE regardless of how good a severance package they get; they nearly always think they deserve more. Which is why it will almost certainly be worth it for you to pay each of them enough to get each and every one of them to sign a settlement agreement in addition to everything else. I understand why you do not want to pay most of your employees anything right now, but it will probably end up making financial sense to do so.

Our China lawyers continued working with this company on a strategy and as time went on, their anger subsided and they chose not to shut down or layoff all of their China employees. But for anyone out there thinking of shutting down their WFOE or laying off all or nearly all of your China employees and needing some ultra-quick advice, the above should do, with the usual proviso that China’s laws on this sort of thing are always changing and always hyper-local.

Dan Harris is internationally regarded as a leading authority on legal matters related to doing business in China and in other emerging economies in Asia. Forbes Magazine, Business Week, Fortune Magazine, BBC News, The Wall Street Journal, The Washington Post, The Economist, CNBC, The New York Times, and many other major media players, have looked to him for his perspective on international law issues.

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